Jonathan Stempel
NEW YORK: Standard & Poor's on Thursday cut Hewlett-Packard Co.'s
long-term debt ratings three notches because of falling profits and risks
associated with its proposed merger with lower-rated rival Compaq Computer Corp.
The downgrade generated a quick response from Palo Alto, California-based
Hewlett-Packard, the world's No. 2 computer maker, which said it was
"disappointed" with the rating agency's decision.
Hewlett-Packard faces a March 19 shareholder vote on the bitterly contested
all-stock merger, valued at $21.5 billion. On Wednesday the company, led by
Chief Executive Carly Fiorina, won Federal Trade Commission approval for the
merger, and on Tuesday the influential Institutional Shareholder Services
advisory firm endorsed the merger.
S&P cut Hewlett-Packard's senior unsecured debt three notches to
"A-minus," its fourth-lowest investment grade, from
"AA-minus," and its short-term debt rating two notches to
"A-2" from "A-1-plus." It warned more cuts are possible.
Downgrades ordinarily boost borrowing costs.
"While there is upside potential for HP's profitability and overall
business profile" from the merger, there remains downside risk from such a
"substantial and large" transaction, said Martha Toll-Reed, an S&P
analyst, in a conference call. She said the merger's "execution risks are
significant."
Hewlett-Packard shares closed Thursday on the New York Stock Exchange at $20,
down 18 cents, and down 14 percent since the merger was announced Sept. 3.
Compaq shares closed on the Big Board at $11.15, up 17 cents. They have fallen
10 percent since the announcement.
Hewlett-Packard's 5.75 percent notes maturing in 2006 yielded 6.19 percent
late Thursday, or 1.6 percentage points more than five-year U.S. Treasuries, a
trader said.
'Well-telegraphed'
S&P said even if Hewlett-Packard hadn't announced the merger, its
ratings would have fallen to a "comparable" level because of weakening
profitability and earnings predictability, especially in its hardware unit.
"The downgrade had been well-telegraphed," said Don Clark, a
portfolio manager who helps invest $15 billion of bonds for ING Aeltus Group in
Hartford, Connecticut. He didn't say if he owns Hewlett-Packard bonds.
S&P rates Houston-based Compaq's senior debt "BBB," two notches
below Hewlett-Packard, and said it may raise or cut that rating.
Responding to the downgrade, Hewlett-Packard Treasurer Larry Tomlinson said
in a statement the merger "addresses many of the issues raised by
S&P" and creates a "healthy PC business capable of generating
significant cash." The company said it had $7.1 billion of cash and
short-term investments, and $4.5 billion of long term debt, as of Jan. 31.
Moody's Investors Service rates the company's long- and short-term debt
"A2" and "P-1," one notch above S&P's ratings.
Opposition, liquidity
Hewlett-Packard faces impassioned opposition to the merger from Walter
Hewlett, a son of company co-founder William Hewlett. He has assembled a bloc of
roughly 20 percent of shareholders to oppose the merger.
Todd Glass, a spokesman for Walter Hewlett, on Thursday agreed with S&P
assessment, saying in a statement that the merger carries
"unacceptable" risks.
S&P said the merger has "strategic validity" for
Hewlett-Packard, and Toll-Reed said the company has a business profile "on
the high end of average." Still, she said Hewlett-Packard's earnings could
be hurt in a hotly competitive and quickly evolving technology market.
The downgrade could make it tougher for Hewlett-Packard to sell commercial
paper -- S&P estimated the company has less than $1 billion -- because many
investors can buy little or no "A-2" rated paper.
Still, Bill Wetreich, another S&P analyst, said on the call that
"liquidity is not an issue ... and refinancing commercial paper really
isn't a major concern." If the merger falls apart, Toll-Reed said
"given the amount of time HP has invested ... we do not assume that it will
be business as usual. We will reevaluate the ratings."
Though it remains rare, companies are more often responding publicly to
negative actions by credit rating agencies, which often weaken investor
sentiment. Other companies to do so include software maker Computer Associates
International Inc. and tire maker Goodyear Tire & Rubber Co.